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Saturday, October 9, 2010

Banks and Favors

The new credit card rules will make it difficult for banks and credit card processors to be tricksters, which is my word for their erratic and arbitrary fees and penalties. Despite the hostile opinions toward banks reported in the popular media they continue to have their way in financial matters.

Take the student loan program where Congress decides that banks will get special favors to make student loans in the student loan program. Starting the early 1990s, college financial offices have been able to choose between a direct government loan and private lending by banks with a government guarantee against default. Summary reports indicate that private loans are now more than half of student loans. In 18 years private lenders jumped from nothing to more than half of student loans.

For the government to make loans the original principal for the loans has to come from a Department of Education appropriation. However, when the government is the lender they receive the interest and principal payments which can then be recycled as new loans.

With principal and interest returned to the government the student loan program can be a self sustaining program without the need of a yearly appropriation. The interest payments received as students pay their loans can be added to the principal to make more loans, reduce interest rates in the future, or fund grants for especially needy students.

With private sector loans the Federal Government accepts the financial risk of default to private lenders, but the interest payment and principal goes to the bank. That means more than half of student loans can generate losses but no revenue for more student loans.

The Obama administration wants to make student loans a self perpetuating program and eliminate student loan guarantees to private banks. A House bill that would make the switch to direct government lending passed in early 2010 over strong industry and Republican opposition. Industry spokesmen say the bill is a government takeover that would squelch competition, diminish services to students and cost jobs.

The use of the word takeover is ironic since the student loan program goes back just over 40 years, but the subsidy for banks was introduced and passed in 1992 with the support of the President Clinton, a democrat. The Obama proposal suggests a take back, but hardly a take over.

Competition in student loans suggests bank offers of discounted interest rates to students to get their business from other banks. Instead, Congress sets the interest rates for both subsidized and unsubsidized student loans with rates reset June 30th of each year. The published interest rate implies a maximum rate, but it serves as a minimum rate.

I say minimum rate because I do not hear of banks offering a rate lower than the published rate. Having one rate and treating it as the rate for student loans eliminates competition that is a normal part of banking. There should be evidence of competition if there is competition.

Judging from the opposition, the subsidy banks want to keep must be larger than I would have guessed. Nearly two years after a banking collapse America has some new rules for credit card users, but nothing else. The media keeps reporting Americans are angry with banks and bankers, but if that is true there is little reform to show for it.